A while ago, in a Facebook note (later reproduced on my web site[1]), I quoted someone who said that the “Austrian” objections to fractional reserve banking is an example of “the rampant rationalism of the Austrian school” – to which I answered that this is an example of the rampant empiricism of some Objectivists.

I won’t address fractional reserve banking here[2] but focus on this accusation against the “Austrians”.

What is rationalism? Originally, it is the name of a school of philosophy (the big names being Descartes, Spinoza and Leibniz) that held that true knowledge is arrived at by reason alone, as apart from experience. – The opposite school, of course, is empiricism (exemplified by John Locke, George Berkeley and David Hume), that held that true knowledge comes from experience, as apart from reason. (There are many differences between those thinkers, but as a rough approximation those definitions hold true.) Those two schools represent two sides of a false dichotomy, but I hardly have to explain this to students/supporters of Objectivism.

But the word is also used by Objectivists in a slightly different sense (the difference being that it is not used about a philosophical school, but about a kind of psycho-epistemological malady): the habit of using abstractions not thoroughly grounded in experience (“floating abstractions”), of making deductions in a cognitive vacuum. – “Empiricism” is also used in a transferred sense: if someone merely gathers disconnected facts and fails to integrate and to abstract from them – if someone is “concrete-bound” – he is said to be an empiricist.

OK, this is a bad habit.

But what makes “Austrian” economics rationalistic in this sense? It is the insistence of Mises and many of his followers that economics is an “aprioristic” science, that its theorems are not derived from experience (they certainly apply to experience, but are not derived from it) The whole of economics, on this view, is derived from the “category of action”, sometimes also called the “axiom of action”. [3] This reflects a heavy Kantian influence on Mises and his followers, and, of course, a Kantian influence is always bad, isn’t it? A theory such as Kant’s can only lead to disasters, when put to practice.

But wait a minute now. Of all the schools of economics, “Austrianism” is the one closest to the truth. It is the only economic school that champions full, laissez-faire capitalism. (There are some “Austrians”, e.g. Hayek, who are not fully consistent on this point, but it is true as a general rule – “for the most part”, as Aristotle would say.) But how could this be, if rationalism and “apriorism” can only have disastrous consequences? Wouldn’t one instead expect the “Austrians” to be Marxists or Keynesians or environmentalists or even theocratic thugs?

Or take the connection to real-life events in today’s world. Who best predicted the current financial crisis? The bursting of such bubbles as the IT bubble and the real-estate bubble? Well, most of them are economists of the “Austrian” school.[4]

Other schools of economics may be accused of “rampant empiricism”. A case in point is the German Historical School. Members of this school merely gathered historical and statistical data, and even rejected the very idea that there can be such things as “economic law” (such as the law of supply and demand). They ended up as socialists (“Kathedersozialisten” or “socialists of the chair”).[5]

There is also a British (or English) Historical School, but it does not seem to be much better. For example, according to Wikipedia:

They rejected the hypothesis of “the profit maximizing individual” or the “calculus of pleasure and pain” as the only basis for economic analysis and policy. They believed that it was more reasonable to base analysis on the collective whole of altruistic individuals. (Italics mine.)

But the paradox remains: If rationalism is such a bad thing, and if Immanuel Kant is the worst of all philosophers (and even “the most evil man in mankind’s history”), then why do we get the best economic theories from someone who was a rampant rationalist, even a Kantian?

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Addendum: A particularly obnoxious example of calling “Austrian” economics rationalist I found in a blog post from 2006 by Diana Hsieh, Fractional Reserve Banking: Fraud or Not?. After quoting the relevant part from Reisman’s Capitalism on why a 100% gold standard is morally superior to any “fractional” system (p. 957f), she dismisses it without giving any real counter-argument, and then writes:

Over the past few years, I’ve heard various Objectivist scholars complain of the heavy rationalism of George Reisman’s work.

Although Diana Hsieh has a PhD in philosophy, she obviously has not learned what is wrong with giving an ad verecundiam argument. But then, “various Objectivist scholars” have good reason to find rationalizations for how they have treated George Reisman. Accusing him of having this psycho-epistemological malady is as good a rationalization as any (or as bad, rather).

In case you are unfamiliar with these terms: “Time preference” refers to the fact that people (everything else equal) prefer a need satisfaction now or in the near future before the same need satisfaction in the more remote future. – “Net consumption” means the consumption of the capitalists, and the “net consumption theory” is the theory that the general level of profit in the economy is equal (or nearly equal) to the consumption of the capitalists. The theory is presented at length in George Reisman’s Capitalism: A Treatise on Economics, chapter 16.

Everything else equal, poor people have a higher time preference and – which is to say the same thing – a lower degree of future orientation than rich people. Take a homeless person, for example: he has to try to survive the day or the week; he is not in a position to set money aside for long-range projects or for his retirement. Another example would be a drug addict, whose time horizon is limited to his next “fix” – or an alcoholic who can only think of his next drink. – A less extreme example would be a poor farmer, who can only plan ahead for one year at a time; he needs this year’s harvest for him and his family to survive, and cannot put away more seed corn than is necessary for the next year’s harvest. (All farmers in Adam Smith’s “rude and early state” would be in this situation.)

At the other end of the spectrum, take a multi-billionaire such as Bill Gates or George Soros: he does not have to worry about surviving the next day, week, month, year or even decade; he can plan ahead for the future without having to concern himself too much with the present. He can even plan ahead for the time after his death and for securing the future of his children and grandchildren.

In between there are the rest of us: people with a moderate or fairly high income. We are in a position to set some of our money aside for the future: for buying a new house or a new car, providing for our children’s education, planning vacations, providing for our retirement.

But everything else is not always equal, so there are exceptions. A poor person may be struggling hard to get out of his poverty; and a very rich person may be squandering his wealth and end up poor.

If you are familiar with The Fountainhead, you may remember that Gail Wynand was sleeping on a couch in his office while building up The Banner and only later used his money to buy a yacht, create an art gallery, and commission a house from Howard Roark. – And for an example of rich people squandering their wealth, read Bernard de Mandeville’s The Fable of the Bees[1].

A change in the time preference of very poor people does little for the economy as a whole. Neither does such a change in the time preference of the few “squandering rich”. It is the time preference of the well-to-do and the industrious rich that makes a difference. As long as those people have a low time preference and a correspondingly high degree of future orientation, they will invest their money, and it is those investments that move the economy forwards.

According to George Reisman’s theory, the level of profit in the economy as a whole is equal to the net consumption of the capitalists (I leave net investment aside, because I don’t think it changes my point). As long as the capitalists have a low time preference, net consumption stays at this low level; the greater part of their wealth goes to productive investments. And the richer they become, the lower becomes their time preference, the more gets invested, the more gets produced, the more workers get employed and the higher their wages become.

But assume that the capitalists’ time preference would increase (and their future orientation would correspondingly diminish); this could happen if there were to be a serious threat of confiscation of their wealth by a socialist government (or if there were certain indications that doomsday was approaching and the world would come to an end). Then the opposite would happen: they would consume their wealth instead of investing it; production would diminish or cease altogether; unemployment would rise; and so would the general level of profit and interest.

And this is why time preference is not a direct but an indirect cause of the level of profit and interest. It works through the net consumption of the capitalists.

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Update December 26, 2015: As George Reisman has pointed out to me in a private message, it is not entirely true that capitalists will continue saving and investing indefinitely. As long as a capitalist is building his fortune, he will save and invest heavily out of his income and consume correspondingly less. But once his fortune is sufficiently large to make his own future – and even his children’s and his grandchildren’s – secure, he will have no incentive to further enlarge it, so he will save and invest less and less and finally may come to the point where he will consume all of his income. (For an extensive discussion of this, see Capitalism: A Treatise on Economics, pp. 739–744.)

I think (this is my own reflection) that this explains why so many of the greatest capitalists establish educational or other foundations (for example Rockefeller and Carnegie, and today Bill Gates and George Soros). From the point of view of the capitalist, this is consumption, since the purpose is not to make more money and enlarge his fortune, but simply to make the best use of the money he no longer needs.

George Reisman also tells me that

capitalists continue to save to the extent that the rate of profit/interest exceeds the rate of their consumption (the rate of net consumption). What causes this is the continuing increase in the quantity of money and volume of spending in the economic system. If the quantity of money and volume of spending ever stabilized at some given level, accumulated capital would grow to the point at which the consumption of the capitalists exhausted the whole of their incomes; at that point, saving out of income would be zero.

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The honor of having discovered the role of time preference goes to Eugen von Böhm-Bawerk. Later “Austrian” economists, such as Mises, have considered his explanation of the causes of time preference as not quite satisfactory. But the one who nails it is, once again, George Reisman:

The nature of human life implies time preference, because life cannot be interrupted. To be alive two years from now, one must be alive one year from now. To be alive tomorrow, one must be alive today. Whatever value or importance one attaches to being alive in the future. one must attach to being alive in the present, because being alive in the present is the indispensable precondition to being alive in the future. The value of life in the present thus carries with it whatever value one attaches to life in the future, plus whatever value one attaches to life in the present for its own sake. In the nature of being alive, it is thus more important to be alive now than at any other, succeeding time, and more important to be alive in each moment of the nearer future than in each moment of the more remote future. If, for example, a person can project being alive for the next thirty years, say, then the value he attaches to being alive in the coming years carries with it whatever value he attaches to being alive in the following twenty-nine years, plus whatever value he attaches in the coming year for its own sake. This is necessarily a greater value than he attaches to being alive in the year starting next year. Similarly, the value he attaches to being alive from next year on is greater than the value he attaches to being alive starting two years from now, for it subsumes the latter value and represents that of an additional year besides.

The greater importance of life in the nearer future is what underlies the greater importance of goods in the nearer future and the perspective-like diminution in the value we attach to goods available in successively more remote periods of the future. (Capitalism: A Treatise on Economics, p. 56.)

To put it in shorter words: To be alive today and this year is the necessary pre-condition of being alive tomorrow or in fifty or a hundred years. Everything else equal, we have to value life in the present over life in the future, for if we don’t, there will be no life in the future. Thus we have to have goods or money to survive the day before we can start thinking about saving for the future.

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I originally wrote this some years ago, when I was pulled into a discussion with an idiot not too well-informed person, who claimed that George Reisman could not be a real “Austrian”, since he does not share the conventional “Austrian” view om time preference.

(Other schools than the “Austrian” have no inkling of the role of time preference.)

Ludwig von Mises (and the “Austrian” school in general) have what they call a “subjective theory of values”; while Objectivism holds that values are as objective as any other form of cognition. (To be precise, it holds that values can and should be objective; there is such a thing as holding irrational or mistaken values.) This looks like a total clash between Objectivism and “Austrianism”; “never the twain shall meet”. But is this really so? Or is this merely a semantic or terminological difference?

Why do the “Austrians” call their theory subjective? One obvious reason is that they reject the notion that value is somehow “inherent” in the objects. No object is valuable “in itself”; they acquire value only in relation to a valuing subject. Also, values vary from person to person; and for the same person, they also vary from time to time. (For example, if I value an ice-cream on a hot summer’s day, it does not mean that I would value that ice-cream in the middle of the winter.)

Also, if values did not vary from person to person, no exchange would be possible. For example, the very fact that I buy an ice-cream for, say, $1 means that at that moment I value the ice-cream over the $1 bill, while the ice-cream vendor values the $1 bill over the ice-cream. If this were not so, no exchange would take place.

But the only thing that is subjective about this is that the object are valuated in relation to a subject and that it is the subject that makes the valuation. (I discussed this at some length in Objectivism versus “Austrian” Economics on Value.) And it should be noted that all cognition, from perception and upwards, is a matter of an interaction between an object and a subject: There is always something that is known and somebody who knows it. To quote Ayn Rand (via John Galt):

Existence exists – and the act of grasping that statement implies two corollary axioms: that something exists which one perceives and that one exists possessing consciousness, consciousness being the faculty of perceiving that which exists. (Emphasis added.)

If somebody argues that all knowledge is subjective, merely because there is a subject involved, he might as well say that all knowledge is objective, merely because there is an object involved. And I think most people grasp this with regard to the physical sciences, but they don’t grasp it with regard to value theory or morality in general.

I once made up an example to demonstrate how values are objective: Imagine two persons meeting in the middle of a desert, with no oasis in sight. One of them is about to starve to death, but he has a bottle of water left. The other one is about to thirst to death, but he has a loaf of bread left. The stage is set for an exchange. And the exchange takes place simply because the starving man values the loaf of bread over his bottle of water, and the thirsting man values the bottle of water over his loaf of bread. The exchange takes place precisely because their values, in that particular moment, differ.

But does this mean that their respective valuations are “merely subjective”? No: it is an objective fact that a man cannot go without food or water for very long before he dies. So that the two persons’ valuations differ does not mean that they are subjective; they are perfectly objective.

You may say that this is an unrealistic example, since this situation rarely, if ever, occurs. In normal life, we are seldom lost in the middle of some desert; much less then under those odd circumstances.

But the principle is equally applicable to the mundane example of buying an ice-cream. You buy the ice-cream and part with your $1 bill, because the sun is hot and you know the ice-cream will quench your thirst; the ice-cream vendor parts with his ice-cream and accepts your $1 bill, because that’s what he does to earn a living. There is nothing subjective about the sun being hot, nor about the necessity to earn one’s living.

Now, I have used a lot of words to explain something that should be fairly self-evident. I hope you get my point.